UOB Kay Hian Research analyst Jonathan Koh has maintained overweight on the Singapore banking sector amid the entry of digital-only banks.

“The odds are against digital-only banks achieving sustainable profitability because customers are demanding and prefer to be served on an omni-channel basis through both online apps and face-to-face interactions at physical branches,” says Koh in a report dated Jan 12.

The number of digital-only challenger banks has increased at a compound annual growth rate (CAGR) of 26% since 2010, and it has expanded three-fold since 2015.

These banks provide online-only and mobile-centric financial services that allow you to access them at anytime and anywhere.

However, Koh notes that digital-only challenger banks are persistently loss-making, compared to the incumbent brick-and-mortar banks.


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The latter has multiple sources of income compared to the digital-only banks that rely on transaction fees.

Customers at digital-only banks hold an average of 1.5 products with the bank, compared to customers holding an average of five products at incumbent banks, says Koh.

“Digital-only banks’ weakness centres on the inability to generate revenue,” he adds. “[For instance], digital-only banks’ loss per customer has deteriorated from €10-€60 ($16.15 -$96.91) pre-Covid-19 to €20-€75 post-Covid-19. Incumbent banks’ profit per customer has deteriorated from €150-€350 pre-Covid-19 to €50-€200 post-Covid-19.”

Furthermore, digital-only banks require continued funding from investors.

According to global management consultancy firm McKinsey, “many digital-only banks cannot sustain a cash consumptive business model”, and that “the Covid-19 pandemic has shortened the runway for many fintechs, posing an existential threat to the sector”.

Funding for such banks has also dried up, notes Koh.

“According to KPMG, total global investment activities in fintech, (encompassing venture capital, private equity and M&A) had dropped by 66% on an annualised basis in 1HFY2020,” he says.

“The party years have ended and investors have started to closely scrutinise the profitability of digital-only banks. Many early-stage fintechs struggled to attract funding. Monzo, a top digital-only bank based in the UK, raised funds at a 40% discount to the previous valuation in June 2020. In its annual report 2020, Monzo warned that its ability to continue as a going concern is subject to material uncertainties,” Koh adds.

How the Covid-19 pandemic has impacted the incomes of digital-only banks

Digital-only banks also failed to shine during the Covid-19 pandemic, a period which saw the rise in e-commerce, online gaming, video streaming and food delivery.

In addition, the drop in consumer spending and overseas travel has resulted in a steep decline in the challenger banks’ incomes during the pandemic due to their heavy reliance on transaction fees.

Customers also seem to have lost faith in Monzo and Revolut, two digital-only banks.

“Monzo and Revolut received a barrage of complaints from customers shut out of their accounts frozen during the lockdown. Hundreds of customers complained that they could not access their funds as their accounts were frozen without notice. This episode of poor customer service will affect customers’ perception on reliability of digital-only banks,” says Koh.

Xinja Bank, a digital-only bank in Australia that was launched in 2019, has recently given its customers the required seven-day notice to close their savings and transaction accounts.

The bank has since refunded customer deposits and returned its banking license to the Australian Prudential Regulation Authority in Dec 2020, as raising capital has become impossible due to the Covid-19 pandemic. The bank will, instead, focus on its US share trading platform Dabble.


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Local banks

As the Covid-19 vaccination is expected to be given to most of the population by 3Q2021, the commencement would improve business confidence, ease safe distancing measures and reduce stress on the corporate sector, this moderating non-performing loan (NPL) formation, notes Koh.

Singapore banks will also get to benefit from lower credit costs in 2021.

“DBS’s and OCBC’s total provisions for 3QFY2020 dropped 35% and 53% q-o-q respectively. DBS’s and OCBC’s credit costs for 3QFY2020 eased to 59 basis points (bp) and 52bp respectively, compared with 104bp and 105bp in 1HFY2020,” he says.

“DBS has maintained guidance for cumulative credit costs in 2020-21 at 80-130bp, while that for OCBC is 100-130bp. For DBS, we estimate 2020 provisions at $2.9 billion, and to drop to $1.6 billion in 2021. OCBC is optimistic that credit costs for 2020-2021 could gravitate towards the bottom-end of management’s guidance at 100bp. For OCBC, we estimate provisions at $2.1 billion for 2020, and to drop to $0.9 billion in 2021,” he adds.

To this end, Koh envisions a gradual normalisation of dividend payouts, as Singapore banks will resume their roles as yield plays.

“We expect DBS to pay 30 cents per quarter in 2021 and 33 cents per quarter in 2022. We expect OCBC to pay 25 cents per half year in 2021 and 28 cents per half year in 2022. Thus, we see dividend yield from DBS improving from 4.0% in 2021 to 4.9% in 2022. Dividend yield from OCBC is expected to improve from 4.7% in 2021 to 5.3% in 2022,” he adds.

Koh has given “buy” recommendations on DBS and OCBC with target prices of $31.48 and $14.62 respectively.

Shares in DBS and OCBC closed $26.88 and $10.65 on Jan 13.